Tuesday, February 28, 2012

Equity markets stay strong - red, caution, or green now?

Equity markets continue to move up. Many suggest caution at this point. That's not unreasonable as it seems like we have been here before, only to see a correction. That does not mean that equity markets are overvalued. Generally speaking, they are not by most historic measures. What it does mean is that as investors build gains, a normal ebb and flow will eventually cause them to take gains and create market edginess for fund management reasons rather than valuation reasons.

Here in ENS land, it's a great relief to say that all but one of the modest family accounts managed are above, some well above, where they were in 2007. This kind of relief is telling. Wouldn't one normally expect that over a five year period that accounts would show some material progress. Happiness is relative.

The years 2008 and 2009(or more specifically August 2008 to May 2009) were a disaster for equities and many other securities as we all know. To have recovered so well for sticking in there feels like a gift, when actually, looked at it critically, we have made little progress when compared to 2007. State retirement funds, corporate pension funds, many mutual funds, and individuals had holes blown in their portfolios and expectations.

Expectations are the issue. With the Fed zero interest rate policy, risk asset investing has been forced up and over the last six months we have seen the result in the equity market. Expectations, however, remain tentative and many retail investors have stayed on the sideline. One can still hear some people speak half-jokingly about their 401K now being a 201K. If that's true, they were scared off to the sidelines and the chalk dust has never again tarnished their shoes.

Limited expectations will force a correction one could reasonably think, or in turn it could motivate further buying as institutional investors know that the skeptical will eventually be forced by herd mentality to jump in with both feet. That will be the top for the near term, and that is impossible to call.

Overall portfolio diversification is a good thing, but at the moment it seems difficult to rebalance and draw down equities. I tend to overstay my welcome by trusting that the market will value securities properly and that business managers who have done well will continue to do so.

How naive is that?

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